If the policy pays out, the benefits are generally taxed as a trading receipt in the year of payment and will be subject to corporation tax. A one-off lump sum payment may artificially increase profits for the year.
The policy may provide the option of receiving benefits in instalments over multiple years which would better reflect the profits lost over time due to the loss of the key person, and stagger the corporation tax liability.
Level of cover required
It can be difficult to assess the likely loss to the business and therefore the level of cover required. Common methods of calculating the amount of cover include using a multiple of salary or considering the profits generated by that individual. The time and cost of replacing a key person should also be considered. An excessive level of cover may result in the premium failing to qualify for corporation tax relief and the potential taxation of the sum assured is also a consideration.
On the death of a shareholder, generally the remaining shareholders would want to retain control of the company and the deceased shareholder’s family would want the cash value of the shares.
Whole-of-life policies are used to direct the shares to the remaining shareholders and provide the family with a cash lump sum.
The company cannot obtain tax relief on whole-of-life premiums because the policy is not for the purposes of ongoing trade but for the benefit of the individuals and their families. Therefore, the directors will pay the premiums themselves out of their taxed income. The policy proceeds are then usually paid tax-free to the nominated beneficiaries.
A company’s articles of association may restrict how shares can be transferred and provisions about the way they are valued, in the event of a shareholder’s death.
There can be significant difficulties in valuing a shareholding of a private company, particularly following the death or illness of a key person that will have a detrimental effect on trade. The value of the shares and the value of the policy are likely to diverge over time as the business grows and so a company’s protection provisions must be regularly reviewed to ensure they are fit for purpose. An independent valuation is required; it should not be done by the company’s own accountant because they are likely to instinctively favour the remaining directors.
Business Property Relief Partnership holdings and shareholdings in unlisted incorporated companies generally qualify for 100 per cent BPR meaning no tax consequences on the passing of shares to other shareholders or on the sum assured paid to the beneficiaries.